Will a loss of profit always be an indirect loss?

13th January 2015

No, the starting point is that a loss of profit may be either a direct or indirect loss. Whether the loss is direct or indirect will depend on the facts of each case. It will be a direct loss if, at the time the contract was entered into, it was likely to result from the breach in question. It will be indirect if there are special circumstances known to the contract breaker at the time of the contract such that a breach would be liable to cause more loss.

This was confirmed as the correct approach in the recent case of Polypearl Limited v E.On Energy Solutions Limited [1].

E.On and Polypearl had entered into two written agreements for Polypearl to supply certain cavity insulation products to E.On. Polypearl claimed that E.On had breached the agreements by failing to purchase a specified minimum amount of those products causing Polypearl to suffer (a) a loss of profits in the sum of £2,103,542 and (b) a loss of opportunity valued at £4,318,037.

However, the master agreement contained two clauses limiting the liability of the parties for breach of contract, which read as follows:

• 10.1 – Neither party will be liable to the other for any indirect or consequential loss (both of which include, without limitation, pure economic loss, loss of profit, loss of business, depletion of goodwill and like loss) howsoever caused (including as a result of negligence) under this agreement, except in so far as it relates to personal injury or death caused by negligence.
• 10.7 – Subject to the above, the aggregate liability of each Party under this agreement for any damage or direct loss howsoever caused (other than death or personal injury caused by the indemnifying party’s negligence) will…be limited to £1,000,000.

The court was asked to consider whether clause 10.1 excluded E.On’s liability and if not, whether clause 10.7 limited E.On’s liability to £1 million.

The court found that clause 10.1 was ambiguous. It was not clear from the drafting whether the words in brackets were intended to cover all loss of profit claims or only indirect loss of profit claims. The court held that the most likely (and often the only) damage that Polypearl would have suffered from E.On’s failure to meet the minimum purchase obligation would be a loss of profits and that the loss of profits in this case was therefore a direct loss of profit. The court found it unlikely that a business man would agree to exclude a direct loss of profit and that, following the rules of construction set out in Rainy Sky [2], it therefore made the most business sense, if clause 10.1 referred only to indirect losses of profit. Clause 10.1 did not therefore exclude E.On’s liability for Polypearl’s loss of profits.

Clause 10.7 on the other hand was clear and unambiguous; it clearly limited the liability of E.On “for any damage or direct loss howsoever caused” to £1 million.

Practical Tips
The burden of proof falls on the party seeking to rely on an exclusion or limitation of liability clause, which must show that the clause, on its true construction, covers the obligation or liability that that party claims it restricts or excludes.

The court will be reluctant to infer that a party has abandoned a legal right without clear, express words to that effect. As a loss of profits can be a direct or indirect loss, the parties need to be clear whether they want to exclude all loss of profit claims and that the drafting clearly reflects their intention.

Exclusions of liability are often hotly contested during contract negotiations, but ultimately it is in neither party’s interest to have an ambiguous clause that could lead to disputes once the contract has been entered into.

[1] [2014] EWHC 3045 (QB)
[2] Rainy Sky SA v Kookmin Bank [2011] UKSC 50 – in this case, the Supreme Court held that where the parties have used unambiguous language, then the court must give effect to it, no matter how unreasonable the result may seem. However, where two interpretations are possible, the court should usually prefer the interpretation which is most consistent with business common sense.